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Samson: The Iraqi economy: from a financing crisis to an exchange rate crisis

31st March, 2021 by Dr. Haider Hussain Al Tohme

The Iraqi economy has gone through critical financial pressures at the beginning of the year 2020 due to the collapse of oil prices in global markets and the decline in oil revenues to below the rates that are printed on the general budgets in Iraq.

Because of the high expenditures of the Iraqi state, the available financial resources were unable to secure sufficient funding to cover the salaries of employees, prompting the government to replace the 2020 budget draft with a borrowing law consisting of (15 trillion dinars for current expenditures and $ 5 billion for investment expenditures) granting the government the ability to finance employee salaries and some necessary expenditures for the purpose of The month of last September.

Given the continued decline in oil revenues, the government was forced to submit a new borrowing bill (worth 12 trillion dinars) to finance public expenditures until the end of 2020. Both loans were financed through the Central Bank and indirectly by deducting treasury transfers, sold to banks and discounted at the Central Bank, which amounted to about (26) trillion dinars, which raised the internal debt from about (35) trillion in 2015 to nearly (64) Trillion in 2020.

The House of Representatives has stipulated that the government’s fiscal deficit be financed by borrowing, the government’s presentation of an integrated reform program that will be a framework for the 2021 budget to ensure that financial and economic reform is firmly implanted in the strength of the federal budget. 

The government submitted the reform paper (the white paper) before the end of the year 2020 to the House of Representatives with guarantees that the general frameworks for the paper would be gradually adopted until the final goals of the reform, represented in diversifying the Iraqi economy, developing the private sector, maximizing non-oil revenues, and other broad economic and social goals.

The House of Representatives stipulated that the government’s fiscal deficit should be funded by borrowing the government’s submission of an integrated reform program that would be a framework for the 2021 budget to ensure that financial and economic reform is firmly implanted in the strength of the federal budget. 

2021 budget and exchange rate change

The exchange rate crisis erupted after the leak of the initial draft of the 2021 budget project and the adoption of a new exchange rate by the Ministry of Finance that would help finance the huge gap between government expenditures and revenues. As the financial pressures facing the Iraqi economy in 2020 prompted the Ministry of Finance to raise the exchange rate of the Iraqi dinar in the federal budget 2021 to (1450 = $ 1) instead of (1182 = $1), in order to maximize government revenues from the export of Iraqi oil by about (10 One trillion dinars. However, the justifications of the Ministry of Finance were not convincing, and the figures in the budget did not match the critical financial dilemma that Iraq is going through, nor the broad promises promoted by the White Paper on financial and economic reform. Government expenditures in the draft 2021 budget have skyrocketed, which does not match the available financial resources nor the purported control and rationalization trends in the white paper. As the total public expenditures amounted to (164) trillion dinars, with total revenues of boat (93) trillion dinars, representing oil revenues (73) trillion dinars and non-oil revenues (20) trillion dinars. Thus, the total planned deficit is (71) trillion, which constitutes (43%) of the total estimated expenditures and an increase of (158%) over the planned deficit for 2019.

Oil and the exchange rate crisis

Just as the collapse of oil prices pressed the exchange rate of the dinar to achieve a financial goal (maximizing oil revenues) and a monetary goal (reducing dollar sales and maintaining the dollar reserve at the central bank), the price recovery also pressed the exchange rate, but this time in the opposite direction, and for political reasons, mostly.

During the past month, Iraq achieved oil revenues that exceeded (5) billion dollars, with an average oil price of (60) dollars per barrel, which maximized government revenues and contributed to the high voices calling for a return to the old exchange rates (1200 = $ 1), after the need to reduce The value of the dinar to finance the government fiscal deficit gap. And also in order to counter the wave of price rises that the local markets witnessed recently, and in excess of the reduction rate, as a result of weak government control and the greed of merchants and suppliers by exploiting the high exchange rate to inflate prices. The exchange rate has become a heavy meal for the Iraqi media, especially with the end of the countdown to approve the budget, the approaching election season, and the increasing fever of auctions and political drop between the political blocs and parties in Iraq. For the exchange rate to generate a new political crisis in addition to the accumulated and widening economic and social crises since 2003.

The repercussions of reducing the exchange rate

Despite the difficulty of timing in which the monetary shock was passed on to the economy, the restoration of political pressure on the central bank and the government to restore the exchange rate to its previous level, usually for electoral purposes, faces several obstacles, the most important of which is the legal obstacle. The 2021 budget, if done, given that determining the exchange rate is within the authority of the Central Bank in accordance with Article (4) of the amended Central Bank of Iraq Law No. (56), which stipulates the exclusive responsibility of the Central Bank in formulating and implementing monetary policy and exchange rate policy in Iraq. 

The Federal Court ruled in 2015 in favor of the Central Bank in the appeal submitted by the latter against the parliament’s decision to add Article (50) to the 2015 budget, which obliges the Central Bank to determine the ceiling for the bank’s dollar sales not to exceed $ 75 million per day.

On the other hand, changing the exchange rate again, and under political pressure, weakens the independence of the Central Bank and thus loses confidence in monetary policy in Iraq and has negative repercussions on the business climate in the country. Also, returning the exchange rate to its previous level does not guarantee the return of price levels to their initial rates due to the inelasticity of prices towards decline, especially in the Iraqi economy.

What makes the matter more dangerous is the introduction of exchange rates into the global oil price cycle, as raising and lowering the exchange rate in response to the decline and rise in oil prices in global markets increases the dependence of the Iraqi economy on the oil resource and doubles the chances of external shocks infiltrating the country through financial channels (the general budget) and channels Monetary (exchange rate), and thus threatening the Iraqi economy with double economic shocks (financial and monetary) that increase the existing economic imbalance and link financial and economic stability to fluctuations in oil prices in the future.   LINK

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